Trevor Petch says closer analysis shows that it would be wise not to anticipate too much from proposals for reform of German capital gains tax.
Announcing its tax reform 2000 plan in mid-December, the German finance ministry failed to draw attention to a major proposal to abolish capital gains tax on sales of share holdings by corporate entities. It took the market two days to notice.
When the market did wake up, the effect was electric: between 21 December and the end of January, Munich Re's share price rose by 35% and Allianz's by 18%. (The market had already priced in a more active Allianz investment policy in September, when the appointment of Paul Achleitner from Goldman Sachs as chief financial officer was announced.)
The government's aim is to generate “an important stimulus to the necessary modernisation and restructuring of the economy” - in other words, the unwinding of stakes long held by (mainly)insurers and banks in other enterprises. This would create substantial increases in the free float of many large German companies. The tax reform package as a whole is also designed to stimulate growth by encouraging investment, by abolishing discrimination against retained earnings compared with distributed. The abolition of the tax credit system will also make investment in German for transparent for international investors.
The government implies that the measure has no revenue effect, as disposals have been minimal in the past and will be minimal, in future, without it. A tax rate of nil is not, however, necessary to make the unwinding of large shareholdings far more tractable, and of smaller holdings very attractive.
A rate of 15% would be half that prevailing in other major investment markets. That alone calls into doubt whether the logical consistency of a zero rate will win out over budget income, and the ease with which Chancellor Schroeder could appease simultaneously the left of the SDP and the opposition with a modest rate of tax.
The market seems to have shrugged off any such reservations. Both Allianz and Munich Re are, of course, among the main potential beneficiaries of the proposal. Other (re)insurers are not, because they have comparatively small portfolios of long-term investments. But even for them, a major benefit would be to restrict to 1999-2000 any “double taxation” effect from the realisation of gains to meet newly introduced tax payments on from “realistic” claims reserving and the discounting of loss reserves.
For 1999, the German non-life operations of Allianz saw the effective tax rate (on a German accounting basis) increase from 54% to 70% in a year when the basic rate of tax fell from 45% to 40%. Allianz and Munich Re are not, however, in exactly the same position. Apart from its interests in Allianz, in primary insurers which support long-term commercial relationships, and two banks with which ERGO has distribution agreements, Munich Re's long-term investments are either under 7% or of little financial importance. Allianz has a far larger portfolio in terms of number of holdings and their size, including over 10% in a dozen companies which appear to be non-strategic. Without externally driven consolidation, it is not certain that these would be as liquid as small stakes like Siemens, easily backed into a convertible bond.
Although both Allianz and Munich Re have 25% cross holdings, these stakes fulfil a strategic function. Munich Re's stake in Allianz is worth far more (1.7x) than Allianz's in it. Furthermore, of the residual and anomalous interests at sub-parent level, Munich Re's are far more substantial than Allianz's: over 40% of Allianz Leben, and nearly half of Frankfurter Leben and Bayerische Versicherungsbank compared with 36% of the far smaller Karlsruher Leben. Allianz Leben has a substantial long-term equity portfolio of its own, including most of the group's stakes over 10%.
This adds further difficulties. The interest of policyholders in any of these gains remains an open question. It might legally be 90% or, by customary payout ratio, even higher. Whatever the size of the gain, Allianz owns half, Munich Re 40% and other shareholders about 10%. It seems to us to be optimistic to credit Allianz with much of this notional gain today or until the ownership of Allianz Leben is rationalised, which will not necessarily be soon either.
Taking the easily realisable gains of both companies - the oddments of under 7% - and placing them on the prevailing price to (IAS) book multiple yields a price no higher than that the companies reached at the end of January (after allowing modestly, in Allianz's case, for the “Achleitner effect”), and lower than the prices they reached in mid-January and mid-February. Positive though the proposal is for both, if there is something waiting around the corner, it is likely to be disappointment.
Trevor Petch is an insurance analyst with Robert Fleming Securities Ltd, London.